PEOPLES BANCORP OF NORTH CAROLINA, INC. The following is a discussion of the financial position and results of operations of the Company and should be read in conjunction with the information set forth under Item 1A Risk Factors and the Company's Consolidated Financial Statements and Notes thereto on pages A-26 through A-71 of the Company's 2020 Annual Report to Shareholders which is Appendix A to the Proxy Statement for theMay 6, 2021 Annual Meeting of Shareholders. Introduction Management's discussion and analysis of earnings and related data are presented to assist in understanding the consolidated financial condition and results of operations of the Company. The Company is the parent company of the Bank and a registered bank holding company operating under the supervision of theBoard of Governors of theFederal Reserve System (the "Federal Reserve"). The Bank is aNorth Carolina -chartered bank, with offices inCatawba ,Lincoln ,Alexander ,Mecklenburg ,Iredell andWake counties, operating under the banking laws ofNorth Carolina and the rules and regulations of theFederal Deposit Insurance Corporation . Overview Our business consists principally of attracting deposits from the general public and investing these funds in commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. Our profitability depends primarily on our net interest income, which is the difference between the income we receive on our loan and investment securities portfolios and our cost of funds, which consists of interest paid on deposits and borrowed funds. Net interest income also is affected by the relative amounts of our interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, a positive interest rate spread will generate net interest income. Our profitability is also affected by the level of other income and operating expenses. Other income consists primarily of miscellaneous fees related to our loans and deposits, mortgage banking income and commissions from sales of annuities and mutual funds. Operating expenses consist of compensation and benefits, occupancy related expenses, federal deposit and other insurance premiums, data processing, advertising and other expenses. Our operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The earnings on our assets are influenced by the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of theFederal Reserve , inflation, interest rates, market and monetary fluctuations. Lending activities are affected by the demand for commercial and other types of loans, which in turn is affected by the interest rates at which such financing may be offered. Our cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. These factors can cause fluctuations in our net interest income and other income. In addition, local economic conditions can impact the credit risk of our loan portfolio, in that (1) local employers may be required to eliminate employment positions of individual borrowers, and (2) small businesses and commercial borrowers may experience a downturn in their operating performance and become unable to make timely payments on their loans. Management evaluates these factors in estimating the allowance for loan losses and changes in these economic factors could result in increases or decreases to the provision for loan losses. COVID-19 has adversely affected, and may continue to adversely affect economic activity globally, nationally and locally. Following the COVID-19 outbreak inDecember 2019 andJanuary 2020 , market interest rates declined significantly, with the 10-yearTreasury bond falling below 1.00% onMarch 3, 2020 for the first time. Such events generally had an adverse effect on business and consumer confidence and the Company and its customers. OnMarch 3, 2020 , the Federal Reserve Federal Open Market Committee ("FOMC") reduced the target federal funds rate by 50 basis points to a range of 1.00% to 1.25%. Subsequently onMarch 16, 2020 , theFOMC further reduced the target federal funds rate by an additional 100 basis points to a range of 0.00% to 0.25%. These reductions in interest rates and other effects of the COVID-19 pandemic had an adverse effect on the Company's financial condition and results of operations. Prior to the occurrence of the COVID-19 pandemic, economic conditions, while not as robust as the economic conditions during the period from 2004 to 2007, had stabilized such that businesses in our market area were growing and investing again. The uncertainty expressed in the local, national and international markets through the primary economic indicators of activity were previously sufficiently stable to allow for reasonable economic growth in our markets. See COVID-19 Impact below for additional information regarding the impact of the COVID-19 pandemic on the Company's business. Although we are unable to control the external factors that influence our business, by maintaining high levels of balance sheet liquidity, managing our interest rate exposures and by actively monitoring asset quality, we seek to minimize the potentially adverse risks of unforeseen and unfavorable economic trends. 29 Table of Contents Our business emphasis has been and continues to be to operate as a well-capitalized, profitable and independent community-oriented financial institution dedicated to providing quality customer service. We are committed to meeting the financial needs of the communities in which we operate. We expect growth to be achieved in our local markets and through expansion opportunities in contiguous or nearby markets. While we would be willing to consider growth by acquisition in certain circumstances, we do not consider the acquisition of another company to be necessary for our continued ability to provide a reasonable return to our shareholders. We believe that we can be more effective in serving our customers than many of our non-local competitors because of our ability to quickly and effectively provide senior management responses to customer needs and inquiries. Our ability to provide these services is enhanced by the stability and experience of our Bank officers and managers. COVID 19 Impact Overview. The COVID-19 pandemic has caused unprecedented disruption that has affected daily living and negatively impacted the global economy, the banking industry and the Company. While we are unable to estimate the magnitude, the COVID-19 pandemic and the related global economic crisis may adversely affect our future operating results. As such, the impact of the COVID-19 pandemic on future fiscal periods is subject to a high degree of uncertainty. The emergence of COVID-19 and new variants of the virus around the world, and particularly inthe United States andCanada , continues to present significant risks to the Company, not all of which the Company is able to fully evaluate or even to foresee at the current time. The pandemic has affected the Company's financial results and business operations, and economic and health conditions inthe United States and across most of the globe have continued to change since the beginning of the pandemic. Management cannot predict the full impact of the pandemic on the Company's management and employees, its customers nor to economic conditions generally, and such effects could exist for an extended period of time. Effects on Our Market Areas. Our commercial and consumer banking products and services are offered primarily inNorth Carolina where individual and governmental responses to the COVID-19 pandemic led to a broad curtailment of economic activity beginning inMarch 2020 . InNorth Carolina , schools closed for the remainder of the 2019-2020 academic year, businesses were ordered to temporarily close or reduce their business operations to accommodate social distancing and shelter in place requirements, non-critical healthcare services were significantly curtailed and unemployment levels rose. Since the initial shut down inMarch 2020 , phased reopening plans began in mid-May of 2020 and continued through mid-May of 2021 subject to public health guidelines, restrictions and limitations on capacity. Inmid-May 2021 , as the number of COVID-19 cases decreased and COVID-19 vaccinations increased and new guidance was issued by theCenter for Disease Control for fully vaccinated individuals, the COVID-19 restrictions were primarily lifted inNorth Carolina allowing businesses to operate in a manner in which they operated prior to the COVID-19 pandemic. Inmid-July 2021 , despite vaccinations being readily available to all individuals living inNorth Carolina over the age of 12, COVID-19 vaccinations rates slowed and the number of COVID-19 cases started to rise and continued to rise throughSeptember 2021 . During that time frame, several local communities re-instated mask requirements and strongly encouraged North Carolinians to get vaccinated, while some companies and government agencies adopted policies and procedures regarding vaccination and regular COVID-19 testing. Sincemid-October 2021 , COVID-19 cases have started to decrease. We are unable to predict if COVID-19 cases will continue to decrease, if additional policies, procedures, restrictions, limitations and mandates will be implemented requiring employees to be vaccinated and/or be subject to regular COVID-19 testing and the impact that the foregoing will have on businesses, including the business of the Company and its customers. Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:
· The
by 0.5 percent on
2020, reaching a current range of 0.0 - 0.25 percent.
· On
a
individuals, supplemental unemployment insurance benefits and a
billion loan program administered through the SBA, referred to as the PPP.
Under the PPP, small businesses, sole proprietorships, independent
contractors and self-employed individuals could apply for loans from
existing SBA lenders and other approved regulated lenders that enrolled in
the PPP loan program, subject to numerous limitations and eligibility
criteria. After the initial
exhausted, an additional
authorized. On
Businesses, Nonprofits and Venues Act (the "Economic Aid Act") became law.
The Economic Aid Act reopened and expanded the PPP loan program. The
changes to the PPP loan program allowed new borrowers to apply for a loan
under the original PPP loan program and the creation of an additional PPP
loan for eligible borrowers. The Economic Aid Act also revised certain PPP
requirements, including aspects of loan forgiveness on existing PPP loans.
Under the Economic Aid Act, the PPP loan program was set to expire on
on March 30, 2021 extended the PPP loan program until May 31, 2021 . The
Bank participated as a lender in the PPP loan program. In addition, the
CARES Act provides financial institutions the option to temporarilysuspend certain requirements under GAAP related to TDR loans for a limited
period of time to account for the effects of COVID-19. See Note 3 of the
financial statements for additional disclosure of loan modifications as of
September 30, 2021 .
30
Table of Contents
· On
Statement on Loan Modifications and Reporting for Financial Institutions,
which, among other things, encouraged financial institutions to work
prudently with borrowers who are or may be unable to meet their
contractual payment obligations because of the effects of COVID-19, and
stated that institutions generally do not need to categorize
COVID-19-related modifications as TDRs and that the agencies will notdirect supervised institutions to automatically categorize all COVID-19
related loan modifications as TDRs. See Note 3 of the financial statements
for additional disclosure of loan modifications as of
· On
at supporting small and mid-sized businesses, as well as state and local
governments impacted by COVID-19. The Federal Reserve announced the MainStreet Business Lending Program, which established two new loan facilities
intended to facilitate lending to small and mid-sized businesses: (1) the
Main Street New Loan Facility, or MSNLF, and (2) the Main Street Expanded
Loan Facility, or MSELF. MSNLF loans are unsecured term loans originated
on or after
tranches of existing loans originated before
size of the program is up to
businesses with up to 10,000 employees or
In addition, the
support state and local governments with up to
with the
funds appropriated by the CARES Act. The facility makes short-term
financing available to cities with a population of more than one million
or counties with a population of greater than two million. The Federal
Reserve expanded both the size and scope of its Primary and Secondary
Market Corporate Credit Facilities to support up to
to corporate debt issuers. This will allow companies that were investment
grade before the onset of COVID-19 but then subsequently downgraded after
Reserve announced that its Term Asset-Backed Securities Loan Facility will
be scaled up in scope to include the triple A-rated tranche of commercial
mortgage-backed securities and newly issued collateralized loan
obligations. The size of the facility is $100 billion . The Bank did not
participate in the MSELF or MSNLF.
· In addition to the policy responses described above, the federal bank
regulatory agencies, along with their state counterparts, issued a stream
of guidance in response to the COVID-19 pandemic and taken a number ofunprecedented steps to help banks navigate the pandemic and mitigate its
impact. These include, without limitation: requiring banks to focus on
business continuity and pandemic planning; adding pandemic scenarios to
stress testing; encouraging bank use of capital buffers and reserves in
lending programs; permitting certain regulatory reporting extensions;
reducing margin requirements on swaps; permitting certain otherwise
prohibited investments in investment funds; issuing guidance to encourage
banks to work with customers affected by the pandemic and encourage loan
workouts; and providing credit under the Community Reinvestment Act
("CRA") for certain pandemic related loans, investments and publicservice. Moreover, because of the need for social distancing measures, the
agencies revamped the manner in which they conducted periodic examinations
of their regular institutions, including making greater use of off-site
reviews. The
institutions to utilize its discount window for loans and intraday credit
extended by its Reserve Banks to help households and businesses impacted
by the pandemic and announced numerous funding facilities. The FDIC has
also acted to mitigate the deposit insurance assessment effects of
participating in the PPP loan program and the Federal Reserve's PPP
Liquidity Facility and Money Market Mutual Fund Liquidity Facility.
Effects on Our Business. The COVID-19 pandemic and the specific developments
referred to above have had and will likely continue to have an impact on our
business. In particular, we anticipate that a significant portion of the Bank's
borrowers in the hotel, restaurant and retail industries will continue to endure
economic distress, which has caused, and may continue to cause, them to draw on
their existing lines of credit and adversely affect their ability to repay
existing indebtedness, and is expected to adversely impact the value of
collateral. These developments, together with economic conditions generally,
including labor shortages, may also impact our commercial real estate portfolio,
particularly with respect to real estate with exposure to these industries, and
the value of certain collateral securing our loans. As a result, our financial
condition, capital levels and results of operations may be adversely affected,
as described in further detail below.
31
Table of Contents
Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:
· On
resources to achieve appropriate social distancing protocols in all
facilities; in addition, we established mandatory remote work through June
30, 2021 to isolate certain personnel essential to critical business
continuity operations. We also expanded and tested remote access for the
core banking system, funds transfer and loan operations.
· We are actively working with loan customers to evaluate prudent loan
modification terms.
· We continue to promote our digital banking options through our website.
Customers are encouraged to utilize online and mobile banking tools, and
our customer service and retail departments are fully staffed and
available to assist customers remotely.
· We were a participating lender in the PPP loan program. We believed it was
our responsibility as a community bank to assist the SBA in the
distribution of funds authorized under the CARES Act to our customers and
communities.
· On
appointment only services. Branch lobbies were reopened on
One small branch located in an assisted living facility was permanently
closed effective
restrictions. All business functions continue to be operational. We
continue to pay all employees according to their normal work schedule,
even if their work has been reduced. No employees have been furloughed.
While the majority of employees are now working on-site, some employees
whose job responsibilities can be effectively carried out remotely
continue to work from home. Employees working on-site are observing
current public health guidelines. Effective
implemented mask requirements for employees.
Summary of Significant Accounting Policies
The Company's accounting policies are fundamental to understanding management's discussion and analysis of results of operations and financial condition. Many of the Company's accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance. A more complete description of the Company's significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company's 2020 Annual Report to Shareholders which is Appendix A to the Proxy Statement for theMay 6, 2021 Annual Meeting of Shareholders. Many of the Company's assets and liabilities are recorded using various techniques that require significant judgment as to recoverability. The collectibility of loans is reflected through the Company's estimate of the allowance for loan losses. The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectibility. In addition, certain assets and liabilities are reflected at their estimated fair value in the consolidated financial statements. Such amounts are based on either quoted market prices or estimated values derived from dealer quotes used by the Company, market comparisons or internally generated modeling techniques. The Company's internal models generally involve present value of cash flow techniques. The various techniques are discussed in greater detail elsewhere in this management's discussion and analysis and the Notes to the Consolidated Financial Statements. Fair value of the Company's financial instruments is discussed in Note (6) of the Notes to Consolidated Financial Statements (Unaudited) included in this Quarterly Report. Results of Operations Summary. Net earnings were$3.4 million or$0.61 basic net earnings per share and$0.59 diluted net earnings per share for the three months endedSeptember 30, 2021 , as compared to$4.5 million or$0.80 basic net earnings per share and$0.78 diluted net earnings per share for the same period one year ago. The decrease in third quarter net earnings is primarily the result of a decrease in net interest income, a decrease in non-interest income and an increase in non-interest expense, which were partially offset by a decrease in the provision for loan losses during the three months endedSeptember 30, 2021 , compared to the three months endedSeptember 30, 2020 , as discussed below. The annualized return on average assets was 0.83% for the three months endedSeptember 30, 2021 , compared to 1.25% for the same period one year ago, and annualized return on average shareholders' equity was 9.30% for the three months endedSeptember 30, 2021 , compared to 12.81% for the same period one year ago. Year-to-date net earnings as ofSeptember 30, 2021 were$12.1 million or$2.16 basic net earnings per share and$2.10 diluted net earnings per share for the nine months endedSeptember 30, 2021 , as compared to$9.4 million or$1.67 basic net earnings per share and$1.62 diluted net earnings per share for the same period one year ago. The increase in year-to-date net earnings is primarily attributable to an increase in net interest income, a decrease in the provision for loan losses and an increase in non-interest income, which were partially offset by an increase in non-interest expense during the nine months endedSeptember 30, 2021 , compared to the nine months endedSeptember 30, 2020 , as discussed below.
The annualized return on average assets was 1.05% for the nine months ended
32
Table of Contents
Net Interest Income. Net interest income, the major component of the Company's
net earnings, was $10.6 million for the three months ended September 30, 2021 ,
compared to $10.9 million for the three months ended September 30, 2020 . The
decrease in net interest income is due to a $447,000 decrease in interest
income, which was partially offset by a $81,000 decrease in interest expense.
The decrease in interest income is primarily due to a $700,000 decrease in
interest income and fees on loans, which was partially offset by an increase in
interest income on investment securities. The decrease in interest income and
fees on loans is primarily due to a decrease in total loans. The increase in
interest income on investment securities is primarily due to additional
securities purchases due to an increase in excess cash. The decrease in interest
expense is primarily due to a decrease in Federal Home Loan Bank ("FHLB")
borrowings and a reduction in rates paid on time deposits, partially offset by
an increase in interest bearing demand, Money Market and savings deposits.
Interest income was $11.4 million for the three months ended September 30, 2021 ,
compared to $11.9 million for the three months ended September 30, 2020 . The
decrease in interest income is primarily due to a $700,000 decrease in interest
income and fees on loans, which was partially offset by an increase in interest
income on investment securities. The decrease in interest income and fees on
loans is primarily due to a decrease in total loans. During the three months
ended September 30, 2021 , average loans decreased $81.0 million to $889.5
million from $970.5 million for the three months ended September 30, 2020 .
During the three months ended September 30, 2021 , average investment securities
available for sale increased $178.7 million to $378.8 million from $200.1
million for the three months ended September 30, 2020 . The average yield on
loans for the three months ended September 30, 2021 and 2020 was 4.37% and
4.31%, respectively. The average yield on investment securities available for
sale was 1.70% and 2.82% for the three months ended September 30, 2021 and 2020,
respectively. The average yield on earning assets was 2.98% and 3.56% for the
three months ended September 30, 2021 and 2020, respectively.
Interest expense was $861,000 for the three months ended September 30, 2021 ,
compared to $942,000 for the three months ended September 30, 2020 . The decrease
in interest expense is primarily due to a decrease in Federal Home Loan Bank
("FHLB") borrowings and a reduction in rates paid on time deposits, which was
partially offset by an increase in interest bearing demand, Money Market and
savings deposits. During the three months ended September 30, 2021 , average
interest-bearing non-maturity deposits increased $180.9 million to $788.0
million from $607.1 million for the three months ended September 30, 2020 .
During the three months ended September 30, 2021 , average certificates of
deposit increased $928,000 to $103.8 million from $102.9 million for the three
months ended September 30, 2020 . Average FHLB borrowings decreased $70.0 million
to zero for the three months ended September 30, 2021 from $70.0 million for the
three months ended September 30, 2020 . The average rate paid on interest-bearing
checking and savings accounts was 0.29% and 0.32% for the three months ended
September 30, 2021 and 2020, respectively. The average rate paid on certificates
of deposit was 0.68% for the three months ended September 30, 2021 , compared to
0.86% for the same period one year ago. The average rate paid on
interest-bearing liabilities was 0.36% for the three months ended September 30,
2021 , compared to 0.45% for the same period one year ago.
The following table sets forth for each category of interest-earning assets and
interest-bearing liabilities, the average amounts outstanding, the interest
incurred on such amounts and the average rate earned or incurred for the three
months ended September 30, 2021 and 2020. The table also sets forth the average
rate earned on total interest-earning assets, the average rate paid on total
interest-bearing liabilities, and the net yield on total average
interest-earning assets for the same periods. Yield information does not give
effect to changes in fair value that are reflected as a component of
shareholders' equity. Yields and interest income on tax-exempt investments for
the three months ended September 30, 2021 and 2020 have been adjusted to a tax
equivalent basis using an effective tax rate of 22.98% for securities that are
both federal and state tax exempt and an effective tax rate of 20.48% for
federal tax-exempt securities. Non-accrual loans and the interest income that
was recorded on non-accrual loans, if any, are included in the yield
calculations for loans in all periods reported. The Company believes the
presentation of net interest income on a tax-equivalent basis provides
comparability of net interest income from both taxable and tax-exempt sources
and facilitates comparability within the industry. Although the Company believes
these non-GAAP financial measures enhance investors' understanding of its
business and performance, these non-GAAP financial measures should not be
considered an alternative to GAAP. The reconciliations of these non-GAAP
financial measures to their most directly comparable GAAP financial measures are
presented below.
33
Table of Contents
Three months ended Three months ended
September 30, 2021 September 30, 2020
(Dollars in Yield / Yield /
thousands) Average Balance Interest Rate Average Balance Interest Rate
Interest-earning
assets:
Loans receivable $ 889,455 9,807 4.37 % $ 970,529 10,507 4.31 %
Investments -
taxable 227,026 657 1.15 % 88,823 484 2.17 %
Investments -
nontaxable* 155,986 972 2.47 % 118,920 985 3.30 %
Federal funds
sold - - 0.00 % 135,548 33 0.10 %
Other 262,205 89 0.13 % 29,503 21 0.28 %
Total
interest-earning
assets 1,534,672 11,525 2.98 % 1,343,323 12,030 3.56 %
Non-interest
earning assets:
Cash and due
from banks 29,644 34,906
Allowance for
loan losses (9,313 ) (9,399 )
Other assets 64,439 69,408
Total assets $ 1,619,442 $ 1,438,238
Interest-bearing
liabilities:
Interest-bearing
demand, MMDA &
savings deposits $ 787,985 577 0.29 % $ 607,111 482 0.32 %
Time deposits 103,828 181 0.69 % 102,900 223 0.86 %
FHLB borrowings - - 0.00 % 70,000 103 0.59 %
Trust preferred
securities 15,464 69 1.77 % 15,464 76 1.96 %
Other 29,595 34 0.46 % 32,440 58 0.71 %
Total
interest-bearing
liabilities 936,872 861 0.36 % 827,915 942 0.45 %
Non-interest
bearing
liabilities and
shareholders'
equity:
Demand deposits 528,481 460,615
Other
liabilities 9,439 9,701
Shareholders'
equity 144,650 140,007
Total
liabilities and
shareholders'
equity $ 1,619,442 $ 1,438,238
Net interest
spread $ 10,664 2.62 % $ 11,088 3.11 %
Net yield on
interest-earning
assets 2.76 % 3.28 %
Taxable
equivalent
adjustment
Investment
securities $ 104 $ 162
Net interest
income $ 10,560 $ 10,926 *IncludesU.S. Government agency securities that are non-taxable for state income tax purposes of$14.9 million in 2021 and$17.3 million in 2020. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2021 and 2020. 34 Table of Contents Year-to-date net interest income as ofSeptember 30, 2021 was$33.3 million , compared to$32.9 million for the same period one year ago. The increase in net interest income is due to a$104,000 increase in interest income and a$377,000 decrease in interest expense. The increase in interest income was primarily due to a$107,000 increase in interest income and fees on loans, which was primarily due to an increase in fee income on SBA PPP loans, which was partially offset by a decrease in interest income on loans primarily due to a decrease in total loans. Fee income on SBA PPP loans totaled$3.0 million during the nine months endedSeptember 30, 2021 , compared to$361,000 for the same period one year ago. The decrease in interest expense was primarily due to a decrease in rates paid on interest-bearing liabilities and a decrease in FHLB borrowings. Interest income was$35.9 million for the nine months endedSeptember 30, 2021 , compared to$35.8 million for the nine months endedSeptember 30, 2020 . The increase in interest income was primarily due to a$107,000 increase in interest income and fees on loans, which was primarily due to an increase in fee income on SBA PPP loans, which was partially offset by a decrease in interest income on loans primarily due to a decrease in total loans. During the nine months endedSeptember 30, 2021 , average loans increased$9.2 million to$917.5 million from$926.7 million for the nine months endedSeptember 30, 2020 . During the nine months endedSeptember 30, 2021 , average investment securities available for sale increased$135.3 million to$330.0 million from$194.7 million for the nine months endedSeptember 30, 2020 . The average yield on loans for the nine months endedSeptember 30, 2021 and 2020 was 4.59% and 4.52%, respectively. The average yield on investment securities available for sale was 1.81% and 3.02% for the nine months endedSeptember 30, 2021 and 2020, respectively. The average yield on earning assets was 3.31% and 3.92% for the nine months endedSeptember 30, 2021 and 2020, respectively. Interest expense was$2.5 million for the nine months endedSeptember 30, 2021 , compared to$2.9 million for the nine months endedSeptember 30, 2020 . The decrease in interest expense was primarily due to a decrease in rates paid on interest-bearing liabilities and a decrease in FHLB borrowings. During the nine months endedSeptember 30, 2021 , average interest-bearing non-maturity deposits increased$165.7 million to$732.0 million from$556.3 million for the nine months endedSeptember 30, 2020 . During the nine months endedSeptember 30, 2021 , average certificates of deposit increased$3.2 million to$106.2 million from$103.0 million for the nine months endedSeptember 30, 2020 . Average FHLB borrowings decreased$61.3 million to zero for the nine months endedSeptember 30, 2021 from$61.3 million for the nine months endedSeptember 30, 2020 . The average rate paid on interest-bearing checking and savings accounts was 0.30% and 0.34% for the nine months endedSeptember 30, 2021 and 2020, respectively. The average rate paid on certificates of deposit was 0.74% for the nine months endedSeptember 30, 2021 , compared to 0.94% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.38% for the nine months endedSeptember 30, 2021 , compared to 0.50% for the same period one
year ago.
The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the nine months endedSeptember 30, 2021 and 2020. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders' equity. Yields and interest income on tax-exempt investments for the nine months endedSeptember 30, 2021 and 2020 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities. Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported. The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors' understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below. 35 Table of Contents Nine months ended Nine months ended September 30, 2021 September 30, 2020 (Dollars in Yield / Yield / thousands) Average Balance Interest Rate Average Balance Interest Rate Interest-earning assets: Loans receivable $ 917,473 31,474 4.59 % $ 926,663 31,367 4.52 % Investments - taxable 199,395 1,847 1.24 % 85,887 1,664 2.59 % Investments - nontaxable* 134,893 2,714 2.69 % 116,113 2,930 3.37 % Federal funds sold - - 0.00 % 80,379 178 0.30 % Other 210,855 172 0.11 % 26,618 103 0.52 % Total interest-earning assets 1,462,616 36,207 3.31 % 1,235,660 36,242 3.92 % Non-interest earning assets: Cash and due from banks 30,652 36,372 Allowance for loan losses (9,602 ) (8,059 ) Other assets 63,739 68,276 Total assets$ 1,547,405 $ 1,332,249 Interest-bearing liabilities: NOW, MMDA & savings deposits $ 732,045 1,617 0.30 % $ 566,348 1,455 0.34 % Time deposits 106,158 584 0.74 % 103,047 725 0.94 % FHLB borrowings - - 0.00 % 61,314 270 0.59 % Trust preferred securities 15,464 211 1.82 % 15,483 296 2.55 % Other 29,095 106 0.49 % 28,086 149 0.71 % Total interest-bearing liabilities 882,762 2,518 0.38 % 774,278 2,895 0.50 % Non-interest bearing liabilities and shareholders' equity: Demand deposits 515,433 413,693 Other liabilities 2,298 4,087 Shareholders' equity 146,912 140,191 Total liabilities and shareholders' equity$ 1,547,405 $ 1,332,249 Net interest spread$ 33,689 2.93 %$ 33,347 3.42 % Net yield on interest-earning assets 3.08 % 3.60 % Taxable equivalent adjustment Investment securities$ 347 $ 486 Net interest income$ 33,342 $ 32,861
*Includes
Changes in interest income and interest expense can result from variances in
both volume and rates. The following table presents the impact on the Company's
tax equivalent net interest income resulting from changes in average balances
and average rates for the periods indicated. The changes in interest due to both
volume and rate have been allocated to volume and rate changes in proportion to
the relationship of the absolute dollar amounts of the changes in each.
36
Table of Contents
Three months ended September 30, 2021 Nine months ended September 30, 2021
compared to three months ended compared to nine months ended
September 30, 2020 September 30, 2020
Changes in Changes in Changes in Changes in
(Dollars in average average Total Increase average average Total Increase
thousands) volume rates (Decrease) volume rates (Decrease)
Interest income:
Loans: Net of
unearned income $ (886 ) 186 (700 ) (313 ) 420 107
Investments -
taxable 577 (404 ) 173 1,625 (1,442 ) 183
Investments -
nontaxable 269 (282 ) (13 ) 426 (642 ) (216 )
Federal funds
sold (16 ) (17 ) (33 ) (89 ) (89 ) (178 )
Other 122 (54 ) 68 436 (367 ) 69
Total interest
income 66 (571 ) (505 ) 2,085 (2,120 ) (35 )
Interest
expense:
Interest-bearing
demand, MMDA
& savings
deposits 138 (43 ) 95 396 (234 ) 162
Time deposits 2 (44 ) (42 ) 20 (161 ) (141 )
FHLB borrowings (51 ) (52 ) (103 ) (135 ) (135 ) (270 )
Trust preferred
securities - (7 ) (7 ) - (85 ) (85 )
Other (4 ) (20 ) (24 ) 5 (48 ) (43 )
Total interest
expense 85 (166 ) (81 ) 286 (663 ) (377 )
Net interest
income $ (19 ) (405 ) (424 ) 1,799 (1,457 ) 342
Provision for Loan Losses. The provision for loan losses for the three months
ended September 30, 2021 was a recovery of $182,000 , compared to a provision of
$522,000 for the three months ended September 30, 2020 . The decrease in the
provision for loan losses is primarily attributable to a decrease in reserves on
loans with payment modifications made as a result of the COVID-19 pandemic and a
decrease in reserves in the general reserve pool. At September 30, 2021 , there
were no loans with existing modifications as a result of the COVID-19 pandemic.
At December 31, 2020 , the balance of loans with existing modifications as a
result of the COVID-19 pandemic was $18.3 million . The Company continues to
track all loans that are currently modified or have been modified as a result of
the COVID-19 pandemic. The loan balances associated with COVID-19 pandemic
related modifications have been grouped into their own pool within the Company's
Allowance for Loan and Lease Losses ("ALLL") model as they have a higher
likelihood of risk, and a higher reserve rate has been applied to that pool. All
loans modified as a result of the COVID-19 pandemic, totaling $100.9 million at
September 30, 2021 , have returned to their original terms; however, the effects
of stimulus in the current environment are still unknown, and additional losses
may be present in loans that were once modified. At December 31, 2020 , the
balance for all loans that were then currently modified or previously modified
but returned to their original terms was $119.6 million . The $18.7 million
decrease from December 31, 2020 to September 30, 2021 in the balance of
currently or previously modified loans that had returned to their original terms
is primarily due to loans paid off during the nine months ended September 30,
2021 . Loan payment modifications associated with the COVID-19 pandemic are not
classified as TDR due to Section 4013 of the CARES Act, which provides that a
qualified loan modification is exempt by law from classification as a TDR
pursuant to GAAP.
The provision for loan losses for the nine months ended September 30, 2021 was a
recovery of $863,000 , compared to a provision of $3.5 million for the nine
months ended September 30, 2020 . The decrease in the provision for loan losses
is primarily attributable to a decrease in reserves on loans with payment
modifications made as a result of the COVID-19 pandemic and a decrease in
reserves due to a net decrease in the volume of loans in the general reserve
pool.
Non-Interest Income. Total non-interest income was $6.0 million for the three
months ended September 30, 2021 , compared to $7.1 million for the three months
ended September 30, 2020 . The decrease in non-interest income is primarily
attributable to a $1.7 million decrease in gains on sale of securities.
Non-interest income was $18.0 million for the nine months ended September 30,
2021 , compared to $17.0 million for the nine months ended September 30, 2020 .
The increase in non-interest income is primarily attributable to a $474,000
increase in mortgage banking income due to an increase in mortgage loan volume,
a $820,000 increase in appraisal management fee income due to an increase in the
volume of appraisals and a $1.4 million increase in miscellaneous non-interest
income primarily due to an increase in debit card income resulting from
increased debit card activity and an increase in income on Small Business
Investment Company ("SBIC") investments. These increases in non-interest income
were partially offset by a $2.1 million decrease in gains on sale of securities.
37
Table of Contents
Non-Interest Expense. Total non-interest expense was$12.6 million for the three months endedSeptember 30, 2021 , compared to$11.9 million for the three months endedSeptember 30, 2020 . The increase in non-interest expense was primarily attributable to a$317,000 increase in salaries and employee benefits expense primarily due to increases in incentive compensation and restricted stock expense and a$208,000 increase in professional fees. Non-interest expense was$37.0 million for the nine months endedSeptember 30, 2021 , compared to$34.8 million for the nine months endedSeptember 30, 2020 . The increase in non-interest expense was primarily attributable to a$907,000 increase in salaries and employee benefits expense primarily due to increases in insurance costs and incentive compensation and a$801,000 increase in appraisal management fee expense due to an increase in the volume of appraisals. Income Taxes. Income tax expense was$824,000 for the three months endedSeptember 30, 2021 , compared to$1.1 million for the three months endedSeptember 30, 2020 . The effective tax rate was 19.55% for the three months endedSeptember 30, 2021 , compared to 19.80% for the three months endedSeptember 30, 2020 . Income tax expense was$3.1 million for the nine months endedSeptember 30, 2021 , compared to$2.1 million for the nine months endedSeptember 30, 2020 . The effective tax rate was 20.17% for the nine months endedSeptember 30, 2021 , compared to 18.31% for the nine months endedSeptember 30, 2020 . The increase in the year to date effective tax rate is primarily due to a reduction in non-taxable investments combined with an increase in earnings before income taxes.
Analysis of Financial Condition
Loans. AtSeptember 30, 2021 , loans were$891.0 million , compared to$948.6 million atDecember 31, 2020 . The decrease in loans is primarily due to a$50.2 million decrease in PPP loans due to PPP loans being forgiven by the SBA during the nine months endedSeptember 30, 2021 and a$37.2 million decrease in commercial loans due to loan payoffs during the nine months endedSeptember 30, 2021 . The Company had$25.6 million and$75.8 million in PPP loans atSeptember 30, 2021 andDecember 31, 2020 , respectively. Average loans represented 63% and 74% of average earning assets for the nine months endedSeptember 30, 2021 and the year endedDecember 31, 2020 , respectively.
The Company had
Although the Company has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by real estate, which is dependent upon the real estate market. Real estate mortgage loans include both commercial and residential mortgage loans. AtSeptember 30, 2021 , the Company had$87.5 million in residential mortgage loans,$86.5 million in home equity loans and$526.9 million in commercial mortgage loans, which include$416.8 million secured by commercial property and$110.1 million secured by residential property. Residential mortgage loans atSeptember 30, 2021 include$24.5 million in non-traditional mortgage loans from the former Banco division of the Bank. AtDecember 31, 2020 , the Company had$104.2 million in residential mortgage loans,$96.6 million in home equity loans and$476.7 million in commercial mortgage loans, which include$375.0 million secured by commercial property and$101.7 million secured by residential property. Residential mortgage loans atDecember 31, 2020 include$26.9 million in non-traditional mortgage loans from the former Banco division of the Bank. All residential mortgage loans are originated as fully amortizing loans, with no negative amortization.
The Company had
September 30, 2021 (Dollars in thousands) Number of Balance Non-accrual Loans Outstanding Balance Land acquisition and development - commercial purposes 35$ 7,014 $ - Land acquisition and development - residential purposes 151 20,089 - 1 to 4 family residential construction 96 18,493 - Commercial construction 40 34,413 - Total construction and land development 322$ 80,009
$ -
38
Table of Contents
December 31, 2020
(Dollars in thousands)
Number of Balance Non-accrual
Loans Outstanding Balance
Land acquisition and development -
commercial purposes 36 $ 7,509 $ -
Land acquisition and development -
residential purposes 161 20,444 -
1 to 4 family residential construction 93 18,897 -
Commercial construction 32 47,274 -
Total construction and land development 322 $ 94,124 $ -
Past due TDR loans and non-accrual TDR loans totaled$1.6 million and$3.8 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There were no performing loans classified as TDR loans atSeptember 30, 2021 andDecember 31, 2020 .
There were no new TDR modifications during the three and nine months ended
Allowance for Loan Losses. The allowance for loan losses reflects management's
assessment and estimate of the risks associated with extending credit and its
evaluation of the quality of the loan portfolio. The Bank periodically analyzes
the loan portfolio in an effort to review asset quality and to establish an
allowance for loan losses that management believes will be adequate in light of
anticipated risks and loan losses. In assessing the adequacy of the allowance,
size, quality and risk of loans in the portfolio are reviewed. Other factors
considered are:
· the Bank's loan loss experience;
· the amount of past due and non-performing loans;
· specific known risks;
· the status and amount of other past due and non-performing assets;
· underlying estimated values of collateral securing loans;· current and anticipated economic conditions (including those arising out
of the COVID-19 pandemic); and
· other factors which management believes affect the allowance for potential
credit losses.
Management uses several measures to assess and monitor the credit risks in the loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectability becomes doubtful. Upon loan origination, the Bank's originating loan officer evaluates the quality of the loan and assigns one of eight risk grades. The loan officer monitors the loan's performance and credit quality and makes changes to the credit grade as conditions warrant. When originated or renewed, all loans over a certain dollar amount receive in-depth reviews and risk assessments by the Bank'sCredit Administration . Before making any changes in these risk grades, management considers assessments as determined by the third-party credit review firm (as described below), regulatory examiners and the Bank'sCredit Administration . Any issues regarding the risk assessments are addressed by the Bank's senior credit administrators and factored into management's decision to originate or renew the loan. The Bank's Board of Directors reviews, on a monthly basis, an analysis of the Bank's reserves relative to the range of reserves estimated by the Bank'sCredit Administration . As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. This independent third-party reviews and evaluates loan relationships greater than$1.0 million as well as a sample of commercial relationships with exposures below$1.0 million , excluding loans in default, and loans in process of litigation or liquidation. The third party's evaluation and report is shared with management and the Bank's Board of Directors. Management considers certain commercial loans with weak credit risk grades to be individually impaired and measures such impairment based upon available cash flows and the value of the collateral. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk. Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance for loan losses. The provision for loan losses charged or credited to earnings is based upon management's judgment of the amount necessary to maintain the allowance at a level appropriate to absorb probable incurred losses in the loan portfolio at the balance sheet date. The amount each quarter is dependent upon many factors, including growth and changes in the composition of the loan portfolio, net charge-offs, delinquencies, management's assessment of loan portfolio quality, the value of collateral, and other macro-economic factors and trends. The evaluation of these factors is performed quarterly by management through an analysis of the appropriateness of the allowance for loan losses. 39 Table of Contents The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management's current evaluation of the Bank's loss exposure for each credit, given the appraised value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below. The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two, three, four, or five years' loss experience. This charge-off experience may be adjusted to reflect the effects of current conditions. The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves. Qualitative factors applied in the Bank's ALLL model include the impact to the economy from the COVID-19 pandemic and reserves on loans with payment modifications as a result of the COVID-19 pandemic. AtSeptember 30, 2021 , there were no loans with existing modifications as a result of the COVID-19 pandemic. AtDecember 31, 2020 , the balance of loans with existing modifications as a result of the COVID-19 pandemic was$18.3 million . The Company continues to track all loans that are currently modified or have been modified as a result of the COVID-19 pandemic. The loan balances associated with COVID-19 pandemic related modifications have been grouped into their own pool within the Company's ALLL model as they have a higher likelihood of risk, and a higher reserve rate has been applied to that pool. All loans modified as a result of the COVID-19 pandemic, totaling$100.9 million atSeptember 30, 2021 , have returned to their original terms; however, the effects of stimulus in the current environment are still unknown, and additional losses may be present in loans that were once modified. The unallocated allowance is determined through management's assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management's acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the unallocated portion may fluctuate from period to period based on management's evaluation of the factors affecting the assumptions used in calculating the allowance. There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the three and nine months endedSeptember 30, 2021 , as compared to the three and nine months endedSeptember 30, 2020 . Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates. EffectiveDecember 31, 2012 , certain mortgage loans from the former Banco division of the Bank were analyzed separately from other single-family residential loans in the Bank's loan portfolio. These loans are first mortgage loans made to the Latino market, primarily inMecklenburg County, North Carolina and surrounding counties. These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers. Various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations. Management believes it has established the allowance for credit losses pursuant to GAAP, and has taken into account the views of its regulators and the current economic environment. Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Bank's loan portfolio as of the date of the financial statements. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company. 40 Table of Contents Percentage of Loans By Risk Grade Risk Grade 9/30/2021 9/30/2020 Risk Grade 1 (Excellent Quality) 0.94 % 1.12 % Risk Grade 2 (High Quality) 19.07 % 20.96 % Risk Grade 3 (Good Quality) 69.24 % 65.36 % Risk Grade 4 (Management Attention) 8.15 % 9.93 % Risk Grade 5 (Watch) 1.88 % 1.91 % Risk Grade 6 (Substandard) 0.72 % 0.72 % Risk Grade 7 (Doubtful) 0.00 % 0.00 % Risk Grade 8 (Loss) 0.00 % 0.00 % AtSeptember 30, 2021 , including non-accrual loans, there were three relationships exceeding$1.0 million in the Watch risk grade, which totaled$8.1 million . There were no relationships exceeding$1.0 million in the Substandard risk grade. Non-performing Assets. Non-performing assets totaled$2.7 million atSeptember 30, 2021 or 0.17% of total assets, compared to$3.9 million or 0.27% of total assets atDecember 31, 2020 . Non-accrual loans were$2.7 million atSeptember 30, 2021 and$3.8 million atDecember 31, 2020 . As a percentage of total loans outstanding, non-accrual loans were 0.30% atSeptember 30, 2021 , compared to 0.40% atDecember 31, 2020 . Non-performing assets include$2.6 million in commercial and residential mortgage loans and$59,000 in other loans atSeptember 30, 2021 , compared to$3.5 million in commercial and residential mortgage loans,$226,000 in other loans and$128,000 in other real estate owned atDecember 31, 2020 . The Bank had no loans 90 days past due and still accruing atSeptember 30, 2021 andDecember 31, 2020 . The Bank had no other real estate owned atSeptember 30, 2021 . Deposits. Total deposits atSeptember 30, 2021 were$1.4 billion compared to$1.2 billion atDecember 31, 2020 . Core deposits, which include demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than$250,000 , amounted to$1.4 billion atSeptember 30, 2021 , compared to$1.2 billion atDecember 31, 2020 .
Borrowed Funds. There were no FHLB borrowings outstanding at
Securities sold under agreements to repurchase were
Junior Subordinated Debentures (related to Trust Preferred Securities). Junior subordinated debentures were$15.5 million atSeptember 30, 2021 andDecember 31, 2020 . InJune 2006 , the Company formed a wholly ownedDelaware statutory trust, PEBK Capital Trust II ("PEBK Trust II"), which issued$20.0 million of guaranteed preferred beneficial interests in the Company's junior subordinated deferrable interest debentures. All of the common securities of PEBK Trust II are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase$20.6 million of junior subordinated debentures of the Company, which pay a floating rate equal to three-month LIBOR plus 163 basis points. The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay inDecember 2006 the trust preferred securities issued inDecember 2001 byPEBK Capital Trust , a wholly ownedDelaware statutory trust of the Company, and for general purposes. The debentures represent the sole asset of PEBK Trust II. PEBK Trust II is not included in the Consolidated Financial Statements. The trust preferred securities issued by PEBK Trust II accrue and pay quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments. The net combined effect of the trust preferred securities transaction is that the Company is obligated to make the distributions and other payments required on the trust preferred securities. These trust preferred securities are mandatorily redeemable upon maturity of the debentures onJune 28, 2036 , or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective onJune 28, 2011 . As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.
The Company has no financial instruments tied to LIBOR other than the trust preferred securities issued by PEBK Trust II, which are tied to three-month LIBOR. The one-week and two-monthU.S. dollar-denominated (USD) LIBOR rates will retire onDecember 31, 2021 . The overnight, one-month, three-month, nine-month, and 12-month USD LIBOR rates will continue to be published throughJune 30 ,
2023.
41
Table of Contents
Asset Liability and Interest Rate Risk Management. The objective of the
Company's Asset Liability and Interest Rate Risk strategies is to identify and
manage the sensitivity of net interest income to changing interest rates and to
minimize the interest rate risk between interest-earning assets and
interest-bearing liabilities at various maturities. This is to be done in
conjunction with the need to maintain adequate liquidity and the overall goal of
maximizing net interest income.
The Company manages its exposure to fluctuations in interest rates through
policies established by its Asset/Liability Committee ("ALCO"). ALCO meets
quarterly and has the responsibility for approving asset/liability management
policies, formulating and implementing strategies to improve balance sheet
positioning and/or earnings and reviewing the interest rate sensitivity of the
Company. ALCO tries to minimize interest rate risk between interest-earning
assets and interest-bearing liabilities by attempting to minimize wide
fluctuations in net interest income due to interest rate movements. The ability
to control these fluctuations has a direct impact on the profitability of the
Company. Management monitors this activity on a regular basis through analysis
of its portfolios to determine the difference between rate sensitive assets and
rate sensitive liabilities.
The Company's rate sensitive assets are those earning interest at variable rates
and those with contractual maturities within one year. Rate sensitive assets
therefore include both loans and available for sale securities. Rate sensitive
liabilities include interest-bearing checking accounts, money market deposit
accounts, savings accounts, time deposits and borrowed funds. Average rate
sensitive assets for the nine months ended September 30, 2021 totaled $1.5
billion , exceeding average rate sensitive liabilities of $936.9 million by
$597.8 million .
The Company has an overall interest rate risk management strategy that
incorporates the use of derivative instruments to minimize significant unplanned
fluctuations in earnings that are caused by interest rate volatility. By using
derivative instruments, the Company is exposed to credit and market risk. If the
counterparty fails to perform, credit risk is equal to the extent of the
fair-value gain in the derivative. The Company minimizes the credit risk in
derivative instruments by entering into transactions with high-quality
counterparties that are reviewed periodically by the Company. The Company did
not have any interest rate derivatives outstanding as of September 30, 2021 .
Included in the rate sensitive assets are $203.1 million in variable rate loans
indexed to prime rate subject to immediate repricing upon changes by the FOMC .
The Company utilizes interest rate floors on certain variable rate loans to
protect against further downward movements in the prime rate. At September 30,
2021 , the Company had $126.9 million in loans with interest rate floors. The
floors were in effect on $100.9 million of these loans pursuant to the terms of
the promissory notes on these loans. The weighted average rate on these loans is
0.81% higher than the indexed rate on the promissory notes without interestrate floors.
Liquidity. The objectives of the Company's liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements. Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities. In addition, the Company's liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit. As ofSeptember 30, 2021 , such unfunded commitments to extend credit were$300.0 million , while commitments in the form of standby letters of credit totaled$5.1 million . As ofDecember 31, 2020 , such unfunded commitments to extend credit were$299.0 million , while commitments in the form of standby letters of credit totaled
$4.7 million . The Company uses several sources to meet its liquidity requirements. The primary source is core deposits, which includes demand deposits, savings accounts and non-brokered certificates of deposit of denominations less than$250,000 . The Company considers these to be a stable portion of the Company's liability mix and the result of on-going consumer and commercial banking relationships. As ofSeptember 30, 2021 , the Company's core deposits totaled$1.4 billion , or 98.13% of total deposits. As ofDecember 31, 2020 , the Company's core deposits totaled$1.2 billion , or 97.89% of total deposits. The other sources of funding for the Company are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under agreements to repurchase and FHLB borrowings. The Bank is also able to borrow from theFederal Reserve Bank ("FRB") on a short-term basis. The Company's policies include the ability to access wholesale funding of up to 40% of total assets. The Company's wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits, internet certificates of deposit and certificates of deposit issued to theState of North Carolina . The Company's ratio of wholesale funding to total assets was 0.69% and 0.88% as ofSeptember 30, 2021 andDecember 31, 2020 , respectively. 42 Table of Contents The Bank has a line of credit with the FHLB equal to 20% of the Bank's total assets. There were no FHLB borrowings outstanding atSeptember 30, 2021 andDecember 31, 2020 . AtSeptember 30, 2021 , the carrying value of loans pledged as collateral to the FHLB totaled$140.0 million compared to$165.1 million atDecember 31, 2020 . The remaining availability under the line of credit with the FHLB was$94.6 million atSeptember 30, 2021 compared to$111.4 million atDecember 31, 2020 . The Bank had no borrowings from the FRB atSeptember 30, 2021 orDecember 31, 2020 . FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. AtSeptember 30, 2021 , the carrying value of loans pledged as collateral to the FRB totaled$478.3 million compared to$469.5 million atDecember 31, 2020 . Availability under the line of credit with the FRB was$348.7 million and$340.0 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. The Bank also had the ability to borrow up to$110.5 million for the purchase of overnight federal funds from five correspondent financial institutions as ofSeptember 30, 2021 . The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 42.42% atSeptember 30, 2021 and 28.12% atDecember 31, 2020 . The minimum required liquidity ratio as defined in the Bank's Asset/Liability and Interest Rate Risk Management Policy was 10% atSeptember 30, 2021 andDecember 31, 2020 . Contractual Obligations and Off-Balance Sheet Arrangements. The Company's contractual obligations and other commitments as ofSeptember 30, 2021 andDecember 31, 2020 are summarized in the table below. The Company's contractual obligations include junior subordinated debentures, as well as certain payments under current lease agreements. Other commitments include commitments to extend credit. Because not all of these commitments to extend credit will be drawn upon, the actual cash requirements are likely to be significantly less than the amounts reported for other commitments below. (Dollars in thousands)September 30 ,December 31, 2021 2020 Contractual Cash Obligations
Junior subordinated debentures$ 15,464
15,464
Operating lease obligations 2,997
3,083
Total$ 18,461
18,547
Other Commitments Commitments to extend credit$ 299,972
299,039
Standby letters of credit and financial guarantees written 5,055 4,745 SBIC investments 2,472 2,658 Income tax credits 101 184 Total$ 307,600 306,626 The Company enters into derivative contracts from time to time to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk. Further discussions of derivative instruments are included above in the section entitled "Asset Liability and Interest Rate Risk Management". Capital Resources. Shareholders' equity was$143.5 million , or 8.88% of total assets, atSeptember 30, 2021 , compared to$139.9 million , or 9.88% of total assets, atDecember 31, 2020 . Annualized return on average equity for the nine months endedSeptember 30, 2021 was 9.30%, compared to 12.81% for the nine months endedSeptember 30, 2020 . Total cash dividends paid on common stock were$2.8 million and$3.5 million for the nine months endedSeptember 30, 2021 and 2020, respectively. The Board of Directors, at its discretion, can issue shares of preferred stock up to a maximum of 5,000,000 shares. The Board is authorized to determine the number of shares, voting powers, designations, preferences, limitations and relative rights. The Board of Directors does not currently anticipate issuing any additional series of preferred stock. In February of 2021, the Company's Board of Directors authorized a stock repurchase program, whereby up to$4.0 million will be allocated to repurchase the Company's common stock. Any purchases under the Company's stock repurchase program may be made periodically as permitted by securities laws and other legal requirements in the open market or in privately-negotiated transactions. The timing and amount of any repurchase of shares will be determined by the Company's management, based on its evaluation of market conditions and other factors. The stock repurchase program may be suspended at any time or from time-to-time without prior notice. The Company has repurchased approximately$3.6 million , or 127,597 shares of its common stock, under this stock repurchase program as ofSeptember 30, 2021 . 43 Table of Contents In 2013, the FRB approved its final rule on the Basel III capital standards, which implement changes to the regulatory capital framework for banking organizations. The Basel III capital standards, which became effectiveJanuary 1, 2015 , include new risk-based capital and leverage ratios, which were phased in from 2015 to 2019. The new minimum capital level requirements applicable to the Company and the Bank under the final rules are as follows: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total risk based capital ratio of 8% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 4% (unchanged from previous rules). An additional capital conservation buffer was added to the minimum requirements for capital adequacy purposes beginning onJanuary 1, 2016 and was phased in through 2019 (increasing by 0.625% onJanuary 1, 2016 and each subsequentJanuary 1 , until it reached 2.5% onJanuary 1, 2019 ). This resulted in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the final rules, institutions would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained earnings that could be utilized for such actions. Under the regulatory capital guidelines, financial institutions are currently required to maintain a total risk-based capital ratio of 8.0% or greater, with a Tier 1 risk-based capital ratio of 6.0% or greater and a common equity Tier 1 capital ratio of 4.5% or greater, as required by the Basel III capital standards referenced above. Tier 1 capital is generally defined as shareholders' equity and trust preferred securities less all intangible assets and goodwill. Tier 1 capital includes$15.0 million in trust preferred securities atSeptember 30, 2021 andDecember 31, 2020 . The Company's Tier 1 capital ratio was 15.30% and 15.07% atSeptember 30, 2021 andDecember 31, 2020 , respectively. Total risk-based capital is defined as Tier 1 capital plus supplementary capital. Supplementary capital, or Tier 2 capital, consists of the Company's allowance for loan losses, not exceeding 1.25% of the Company's risk-weighted assets. Total risk-based capital ratio is therefore defined as the ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted assets. The Company's total risk-based capital ratio was 16.19% and 16.07% atSeptember 30, 2021 andDecember 31, 2020 , respectively. The Company's common equity Tier 1 capital consists of common stock and retained earnings. The Company's common equity Tier 1 capital ratio was 13.82% and 13.56% atSeptember 30, 2021 andDecember 31, 2020 , respectively. Financial institutions are also required to maintain a leverage ratio of Tier 1 capital to total average assets of 4.0% or greater. The Company's Tier 1 leverage capital ratio was 9.61% and 10.24% atSeptember 30, 2021 andDecember 31, 2020 , respectively. The Bank's Tier 1 risk-based capital ratio was 15.03% and 14.85% atSeptember 30, 2021 andDecember 31, 2020 , respectively. The total risk-based capital ratio for the Bank was 15.92% and 15.85% atSeptember 30, 2021 andDecember 31, 2020 , respectively. The Bank's common equity Tier 1 capital ratio was 15.03% and 14.85% atSeptember 30, 2021 andDecember 31, 2020 , respectively. The Bank's Tier 1 leverage capital ratio was 9.39% and 10.04% atSeptember 30, 2021 andDecember 31, 2020 , respectively. A bank is considered to be "well capitalized" if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater and a leverage ratio of 5.0% or greater. Based upon these guidelines, the Bank was considered to be "well capitalized" atSeptember 30, 2021 . 44 Table of Contents
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